Macroeconomic and financial market commentary

The day After.

I know I’m late this week. But let me say here, as Mark Twain once did, that the rumors of my death have been greatly exaggerated. I am physically alive… and not bankrupt (yet). Not that these last few days have been easy for us naysayers and permabears. We should never take life itself, or the solidity of our balance sheet (or income statement) for granted.

I painfully and gradually built a short in the E-mini S&P500 march futures, and was already dreaming a Caribbean retirement. It is always about greed and fear. Was my dream too greedy? It must have been, because it all crashed in five days of trading. When I take a look at the SP500 chart (or the IBEX35 index for that matter), I find the drawing quite extraordinary. I had never seen a market turn around technically like that in a life time. It was a sharper turn around than the one in june 2013. At least Central Bankers are enriching our life experience. My epitaph will read: “he saw it (nearly) all”.

Now, I am not saying the market does not have a right to be bullish. The market can do whatever it wants to do, in order to inflict the maximum pain, on the maximum number of participants. But it is a truism it used to respect certain rules. After all, market prices are only a series of numbers that normally show positive serial correlation. It is always clear that the market can change its mind from a bearish set up to a bullish one, in due time, and following certain numerical procedures. A 200 point SP500 round trip in a fortnight, on no news (except central banker timed remarks), is something to talk to my grandchildren about when I grow older (and they do as well). Gestapo, KGB, Stasi, or Mossad are a lot less efficient than POMOs.

Thank god I acknowledged total defeat last week, and left only a residual short in the low to mid 1900’s. I plan to hold on to half that short (leave 5% of the portfolio short the index). I still think the SP500 will pay my retirement extras (see timing the top), but I will have to be patient. Rome wasn’t built in a day. People who held on to their technically logical short positions were crushed. Hedge fund performance in october will be a disaster.

Natural disasters can be awful, but at least they are unpredictable. In this central bank coordinated battle, no POW were taken. POMO desks do not have the mandatory concentration camps for people like us. Losers were all executed in ISIS terrorist style (not to confuse with Isis, the greek godess). It has been a merciless victory for the establishment and the central banks. POMO desks manipulated prices efficiently and coordinately. They looked for stop areas and busted them. They retaliated against any anti-systemic positions in strength. The market did the rest. With the benefit of time, one can see that it was a resounding victory.

And then, last friday, the allied troops organized a celebration day, and Kuroda (he’s one of the allies this time around), put the icing on the cake.

“More free money (against unbridled debt of course). We will all be richer from now on”.

See in the side chart (from daily shot) the new, out of the blue, yen monetary base to be generated asap.

Friday was veritably a great party. And it was fully sponsored and paid for by Abenomics. Women and wine for the victorious POMO troops. How nice of them. The Japanese are cleaning up their bad reputation left overs from world war II.

As I write this, naysayers are all running to the hills for cover. Sometimes I want to run as well. Morale runs as low as it has ever been among the non-believers. POMO desks will even make a trading profit for the month. Another line of history has been written. The show must go on.

Let’s recap shortly were we stand before we all run for cover. The actual “ultra high (and growing) stakes financial poker game”, is based on four factors:

Money printing to ensure liquidity for the bubble. Printing presses can change, but printing has to continue. We need ample liquidity growth to sustain the whole set up. Credit Suisse analysts consider liquidity excess to suffice for another rerating of equities of 10%. Nominal wealth, and a general financial sense of well-being have to be maintained at all costs.

Zero or negative interest rates must be enforced, in order to effectively take the price of money to around zero in a semi-permanent way. Forget the Wicksellian natural rate of interest. Who cares. We want rates as low as possible, for as long as we possibly can. If we were talking about the price of a pound of bread, we would call it price controls. When it is related to money we call it “qualitative monetary policy”. I love euphemisms.

An imposed risk mispricing policy must help. Not only the underlying risk free interest rate has to be close to zero, but risk premiums also have to be set below normal market prices. This is essential. It is no good if only risk free rates are rock bottom, and risky assets have to price in real risks adequately. Who would buy Japanese, Italian, French or Spanish bonds if risk wasn’t significantly underpriced? You misprice risk globally with emphatic public puts by central Banks, in a context of excess money in a desperate search of yield. The “puts” are essential. People have to believe those puts. They have to be enforced from time to time. As last week. Even if it is a bloody enforcement.

Public opinion has to fully believe, and even underwrite with their own money, that the accumulated debt in actual balance sheets, and the debt we are accumulating as I write, will be payable in the future. We need some growth and inflation for that. Investors are dumb, but basic math is still within their intellectual limits. That is the reason for all the fuss about European stagnation and deflation. We have to grow and reflate because our debt requires it. Deflation is not the issue: debt sustainability is.

October is finished, and we have entered a new phase of the game. The day after has been postponed, and stakes have been raised.We are now all in with wife, children and even your dog acting as collateral. Central Banks have reinforced the perception of the validity of their puts with words and acts. They lost some additional credibility in the battle, but, as we all know, not even victors result unscathed after a battle like this. They have also ensured that money printing will continue, Kuroda assuming the new role of money printing cheerleader with Mario Dragui following right behind, as fast as the Germans will allow him to print. Everybody knows ZIRP rates are a given, and might only be lifted in the US, if everything is running smoothly, and not before mid 2015. Risk premiums will remain subdued because everybody is comfortable with central bank puts, and there are no other options available if you need yield.

But, if something cannot go on for ever, it will stop. It’s hard to know which of the said factors of the actual situation will break first. I still insist it won’t be interest rates or inflation that prick the bubble. Having participated in last weeks Waterloo (napoleonic side), it is now clear to me that, given the case, puts will be enforced, and money printing will not stop until the end. But something will have to give, or else we shall print our way to eternity. And that can be long indeed; “L’eternite cést long, surtout vers la fin”. Maybe printing will outlive me. But it is more practical to try and look for fissures and crevasses in this common knowledge, the winner takes it all, game.

Will the break be event driven? A printing press break down? War? Ebola? Or is a growth and inflation scare going to break the debt sustainability belief? Maybe the “Triffin dilemma” will upset things, but I doubt it; they will compensate the liquidity crunch. Central Bankers are smart. And I think EM’s are better off than we think, they can handle the liquidity squeeze Magnus talks about in the next chart. Growth is, for the most part, an entirely different animal.Whatever happens, they will not cease printing. They have tried to twice ( June 2013, and this summer). This last time they tried to moderate liquidity quietly, no fanfare (look at this USD reserve aggregate chart underneath).

It didn’t work, because markets nearly collapsed, and this October they explicitly pushed the panic button in a somewhat disorderly way.

Yes, it’s a one way road folks; quite a few of us told you well in advance. In a normal world, with humble politburo members, there is still a chance they will admit their wrongdoing. But they will not do it. Only Samurais put their honor before their lives. Our central bankers, and the establishment besieging them, are not Samurais. They are way closer to the French figure of the “bon vivant”, or the “gourmand” (not the gourmet). Samurais are old fashioned: they die for their honor !!!!!!

No honor, and, decidedly, no dignity either. I was shocked by the recent remarks by no other than the “maestro”, the dean of this idiotic perma-easy-money policy, as reproduced by zerohedge. A real eyeopener. He said money printing has failed to affect the real economy, and he said where is no easy way out of the corner they have painted themselves in. He expressed skepticism on the chances of exiting the 4.4 trillion balance sheet with no significant disruptions. But it wasn’t his fault. He couldn’t stop this credit expansion without harming the real economy, he said. Amazing. Not even the slightest hint of “mea culpa“. As I have said before, when the rats jump ship we must be near the end. Honor and dignity are major virtues. We need them, and the Samurais, back.

So it will have to be debt sustainability that ends the show. It might take long, because debt numbers are incomprehensible to most of the population, and, unfortunately, a sizable proportion of professional fund managers. ¿Is a total debt load of 1.3 trillion USD sustainable or not for the Spanish economy? People don’t have a clue, and if they do, they will keep their eyes closed and their mouth shut. Thinking is not free anymore. They won’t jail you for it, but you can forget summer parties in luxury houses in residential areas. Or friendly pats in the back by ruling class members.

A sustained combined growth and deflation scare might do the trick. Growth sensitivity to money printing is decreasing every day, and the actual global growth prognosis is poor according to ECRI (chart via Business Insider). I know their reputation has been shattered by the FED, but I still see them as another war casualty of Princeton economics. They are good.

Two outstanding risks for growth, in a context were growth is going to be elusive for as long as this “extend and pretend” game lasts: Europe and China. China is faltering, their growth momentum looks awful.

If we want real figures, we can look at the last official numbers from them. They are crashing to sub 5% growth for sure. Maybe less that 4%. You can take a look at the fresh official lies from last friday. Order backlog doesn’t look good even to them.

On this side of the world, Europe will at best stagnate. And we are not going to make it. It is my firm view, and I saw a full endorsement of it via this chart in Business Insider. We may be both wrong, but it’s good to have some company. Thank you Jesse Livermore, whoever you are. I feel lonely after every defeat, and Central banks have me gasping for fresh air. I’m mentally beaten up.The US will soon feel the pinch from a higher USD. Japan and China will try to export their deflation to the US and Europe asap. The Chinese will not accept the depreciation of the JPY politely. Their mutual hatred goes nearly as deep as the arab-jew world standard for enmity. ISIS and Al Quaeda, vs the US, are also serious contenders for the top loathing Guiness record. More hatred and violence are to come when the Princeton experiment ends. Poverty is, as Ghandi explained, the worst kind of violence. And when this busts we are going to generate a poverty big bang. Poverty will bring violence that will in turn breed violence. It is urgent to dispose of these Princeton related shamans, and glide down to reality as quickly and smoothly as possible.

Well, if it looks like I want a break to happen, you got it right. For a reason. Postponing the end is not a free ride. Free lunches and rides are only for Larry Summers and Ben and Paul Princeton colleagues. All the rest of us will have to pay. The day after is looking worse and worse.Stakes are up every day, and the consequences accumulated for the day after this breaks, are overwhelming. And there will be a day after. Maybe we will not even be able to call it a day. It will be a nightmare. We have to stop this before it gets worse.

In the meantime it’s more of the same.No credit risk because balance sheets are corrupted worldwide (remember for every debtor that defaults there is a creditor that can also default and so on). Play duration longs at will but only tactically, because strategically real money will be in short supply the day after, and interest rates will end going up big. We are long of money and short of wealth. Malinvestments are not wealth, particularly if the are not even auto-sustainable, like ghost cities in China, or municipal empty airports and motorways to nowhere in Spain.

Long or flat the USD. Flat to short against the JPY, EUR and CNY in the different pairs. In other currencies just be alert to Central Bank activity. POMO desks are ruthless. Just for fun, take a look at the SNB balance sheet.

T Jordan et al are scared to death with the next referendum incorporating a very light anchor to their balance sheet (20% of assets to be in gold). The problem is not gold in itself. The problem is putting some limits to balance sheet expansion by the SNB. They are terrified.

In equities, bide your time. The top of the century is still at hand, but we probably have to wait. Risk management is paramount. Keep as much dry powder as you possibly can. Beware of POMO’s on the prowl. They will go for your money, particularly if they find out you are a non-believer. No principles, no moral hazards, just sex.

Preview of “The day after (II)”. We will have to start again. The consolidated global balance sheet will be deflated 30 to 50% after the defaults, and life will go on. We have to set up a new economic system. We have to make sure we do not make the same mistakes again.

We need balanced and small public sectors, balanced trade flows (no substantial beggar-thy-neighbour environments), sound money and no inflation (even deflation if possible), positive interest rates near the Wicksellian level, efficient tax systems, and reasonable wealth inequalities (not the marxist desideratum, but somewhere in between his ideas and actual levels of inequality). And we need a new weighting for the different sectors. Cement and transportation have to lose weight. Biotechnology, education, healthcare, and intelectual output have to gain it.

We need morality, honor, dignity, hard work, and real peace. No shortcuts to wealth. No euphemisms. Growth and aggregate demand are not the one and only desideratums. For a stable real peace, educational levels are key, and zero poverty policy (ZEPP) is to substitute zero interest rate policy (ZIRP). Otherwise, as Ghandi said, the world will be blind before long.